On January 1, A Company Issues Bonds Dated January 1

On January 1 A Company Issues Bonds Dated January 1 With A Par Value

On January 1, a company issues bonds dated January 1 with a par value of $380,000. The bonds mature in 5 years. The contract rate is 7%, and interest is paid semiannually on June 30 and December 31. The market rate is 8%, and the bonds are sold for $364,603. The journal entry to record the first interest payment using straight-line amortization is: Debit Interest Payable $13,300.00; credit Cash $13,300.00. Debit Interest Expense $14,839.70; credit Discount on Bonds Payable $1,539.70; credit Cash $13,300.00. Debit Interest Expense $13,300.00; credit Cash $13,300.00. Debit Interest Expense $11,760.30; debit Discount on Bonds Payable $1,539.70; credit Cash $13,300.00. Debit Interest Expense $14,839.70; credit Premium on Bonds Payable $1,539.70; credit Cash $13,300.00.

Paper For Above instruction

The issuance and accounting treatment of bonds are fundamental aspects of corporate finance, reflecting a company's strategy to raise capital through debt instruments. When a company issues bonds, it commits to periodic interest payments and repayment of principal at maturity. The company's chosen amortization method and the bond's selling price relative to its face value significantly affect the accounting entries and reported financial results. This paper examines the specific case of bond issuance at a face value of $380,000, issued on January 1, with semiannual interest payments, considering market conditions, and explores the correct journal entries, particularly focusing on straight-line amortization versus effective interest methods.

In the provided scenario, the bonds are issued with a par value of $380,000 and a contract (coupon) rate of 7%. However, the bonds are sold at a discount of $15,397, resulting in a sale price of $364,603. This discount arises when the market rate is higher than the contract rate, making the bonds less attractive to investors unless offered at a discount. The bonds’ semiannual interest payment based on the contract rate is calculated as:

• Interest payment per period = $380,000 × 7% / 2 = $13,300

Given that bonds are issued at a discount, the effective interest expense will not match the cash interest paid. Instead, it reflects the amortization of the discount over the bonds' life, impacting the company's reported earnings.

Accounting for Bond Issuance and First Interest Payment

The initial journal entry at issuance records the cash received, the bonds payable account at face value, and the discount on bonds payable:

• Debit Cash $364,603
• Debit Discount on Bonds Payable $15,397
• Credit Bonds Payable $380,000

The question focuses specifically on the first interest payment and its accounting, considering straight-line amortization. Under straight-line amortization, equal amounts of the discount are amortized over the life of the bonds, simplifying the process but sacrificing some accuracy in matching expenses to periods.

The total discount of $15,397 spread evenly over 10 periods (since semiannual payments over 5 years) results in amortization of approximately $1,539.70 per period:

• Amortization per period = $15,397 / 10 = $1,539.70

Therefore, the interest expense for each period under straight-line amortization is the cash interest paid plus the amortized discount:

• Interest Expense = $13,300 (cash interest) + $1,539.70 (amortization) = $14,839.70

The correct journal entry for the first interest payment using straight-line amortization is:

• Debit Interest Expense $14,839.70
• Credit Discount on Bonds Payable $1,539.70
• Credit Cash $13,300

Alternatively, some options mention recording interest expense equal to the cash interest, which is incorrect under amortization of bond discounts. The option that correctly reflects the straight-line amortization approach considers amortizing the discount and adjusting interest expense accordingly, as shown in the journal entries above.

Overall, understanding the difference between straight-line and effective interest methods is vital for accurate financial reporting. While straight-line amortization simplifies calculations, it does not adhere strictly to the matching principle compared to the effective interest method, which allocates interest expense based on the market rate and outstanding balance.

Conclusion

In conclusion, the initial bond issuance at a discount and the subsequent interest expense recognition require careful consideration of amortization method and bond characteristics. The appropriate journal entry for the first interest payment, considering straight-line amortization, includes recording increased interest expense due to amortization of the discount. This method, while simpler, must be used consistently and disclosed properly in financial statements. Accurate accounting for bonds ensures transparency and correct representation of a company's liabilities and expenses, ultimately aiding stakeholders' decision-making.

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